James R. Balmforth: File Bankruptcy Or Try To Settle?

When you’re in need of serious help getting your credit back on track, there are two debt relief options that are worth considering. Both debt settlement and bankruptcy will reduce or eliminate your debt, but can also negatively impact your credit in the near term. Here’s what you need to know about both.

What Is Debt Settlement?

Debt settlement allows you to negotiate with creditors to pay off debt on delinquent, unsecured credit accounts and personal loans for less than you owe. For example, a person with a $10,000 balance on their credit card might pay $4,000 to close and settle the account and have the remaining $6,000 forgiven. Debt settlement is really only a viable option for people who have reliable income. That’s because you’ll need to make each payment you agree to with creditors over the course of your settlement plan, which for some, can last a couple years.

What Is Bankruptcy?

Bankruptcy can give you a fresh start or help you re-organize your debts and pay your creditors less depending upon the type of bankruptcy you file. All bankruptcy provides court-ordered protection from creditors, but the type of bankruptcy you file will depend on your personal financial situation. Chapter 7 allows for your debts to be fully discharged, while Chapter 13 provides for an organized repayment plan (there’s also Chapter 11, though it is most often used by businesses).

How to Decide Which Is Right for You

As you consider debt settlement and bankruptcy, it’s important to take an honest look at the amount of your debt, your budget and your available funds/income. Identify short and long term financial goals and how your credit health will impact these. To assess your qualifications and options for filing bankruptcy, it’s best to speak with a bankruptcy attorney. Most offer a free consultation and you’re under no obligation to file after speaking with them.

If you’d like to consider debt settlement, you can begin by assessing:
• Your balances: Some amounts are too small for settlement.
• Your creditors: Each company has its own approach to dealing with delinquent accounts and their policies change periodically.
• Your cash flow: Do you have the funds to settle all your debts within 18 months or, ideally, 12 months as this reduces the risk of being sued?
• Your budget: Can you pay your settlements on time and still pay your other bills?
• Additional funds: Are there other sources of funds, e.g., something you can sell, loans from family or friends that you can access?

If debt settlement is the right option, you’ll work with a debt settlement company to negotiate on your behalf or you can negotiate directly with each of your creditors. In most cases, filing for bankruptcy will damage your score much more than debt settlement. A Chapter 7 bankruptcy stays on your credit report for 10 years. Chapter 13 stays on for seven. Filing for either type can also lower your credit score by 150 to 200 points. Successfully settled debts are marked as “settled” on your credit report for seven years, but you won’t face as many restrictions during that time period when it comes to borrowing. And your credit score may take a dip that’s just as bad as filing for bankruptcy. The danger is when debt settlement isn’t successful. If you’ve stopped making payments on your debt in anticipation of a successful settlement, you risk defaulting on your debts if it doesn’t come through. You’ll mar your credit report and might be left with no alternative to bankruptcy. Of course, you can continue paying your creditors throughout the settlement process, but most people don’t due to the expense.

Which Is Easier To Qualify For?

Debt settlement typically comes with fewer qualification requirements. Anyone with unsecured debt of $7,500 or more can qualify to enroll in most debt settlement companies, though most don’t operate in all 50 states. In contrast, you have to have less than $1,184,200 in secured debts and $394,725 in unsecured debts to qualify for Chapter 13 bankruptcy. You also have to be employed. Qualifying for Chapter 7 bankruptcy is much more complicated: You must meet a laundry list of criteria that proves you don’t and won’t have the funds to pay your debts. To be eligible for any type of bankruptcy, you’re also required to get credit counseling from an approved agency before filing. And you won’t qualify for bankruptcy if you’ve had a past bankruptcy petition dismissed in the past 180 days.

Filing Chapter 7 Bankruptcy

You have two options when it comes to a bankruptcy filing and they both work differently. In a Chapter 7 bankruptcy, your debt is wiped out, regardless of how much you owe. The kinds of debts you can get rid of through Chapter 7 include medical bills, credit card bills and unsecured loans. Student loans generally can’t be discharged in either type of bankruptcy unless you’ve got a sustained financial hardship that keeps you from making your payments. To file Chapter 7, you have to meet certain income guidelines under the means test. The guidelines are determined using Census Bureau data. They’re based on where you live and how many people are in your family. You have to be at or below the income limit established for your family size to qualify for Chapter 7, unless you can prove that you don’t have enough disposable income to pay a certain percentage of your debt each month. One disadvantage of Chapter 7 is that you may have to give up some of your assets as a trade-off for eliminating your debt. These assets are turned over to the bankruptcy trustee overseeing your case, who’s responsible for liquidating them and using the proceeds to pay your creditors. Depending on where you live, you can claim federal or state exemptions to protect certain assets, like bank accounts, jewelry or vehicles. But there are limits to how much you can exempt.

Chapter 13 is also a way to clear your outstanding debts but the process is a little more involved. Typically, a Chapter 7 bankruptcy can be completed within six to nine months, but it can take up to five years to get a discharge in a Chapter 13 case. Unlike Chapter 7, there are limits to how much debt you can include in a Chapter 13 filing. When you file, you have to agree to pay back some or all of your debts. The amount you have to pay back typically depends on the types of debt included in the bankruptcy and how much you owe. A Chapter 13 payment plan can last three or five years, based on your income. If you default on your payment plan, the case can be dismissed which leaves you open to collection actions and you won’t get back any of the money you paid in. The upside of a Chapter 13 case compared to Chapter 7 is that you get to keep all of your assets. If you’re behind on your mortgage payments, you can also file Chapter 13 to get caught up if a foreclosure is pending. Depending on whether you’re upside down on your home, you could also use a Chapter 13 filing to get rid of a second mortgage.

Debt Settlement Basics

Settling a debt means asking your creditor to accept less than what’s owed to resolve the account. Generally, creditors will only settle a debt once your account falls significantly past due. The amount that you can settle a debt for depends on the creditor, but you may be able to settle for anywhere from 35 to 75 percent of the total balance. There are companies that offer debt settlement services for a fee but it’s possible to settle a debt on your own. Once you decide how much you can afford to pay, you just call the creditor up to get the negotiations started. Typically, you have to be able to make one lump sum payment or several smaller payments if your offer is accepted, so you should only consider settlement if you have cash on-hand. If the creditor is willing to work with you, they may try to make a counteroffer but you should only agree to what you can afford. Once an offer is accepted, you pay the creditor and the remaining balance is forgiven. The account will be reported as “Paid” or “Settled” on your credit and you won’t have to worry about any additional collection actions.

Advantages and Disadvantages of Debt Settlement

Debt settlement can be the best way out of a financial mess, but it is full of pitfalls. The biggest problem is convincing a creditor, or multiple creditors, to accept less than they are owed. Creditors aren’t obligated to enter a settlement agreement, but many are willing if they believe you can’t pay and otherwise will file for bankruptcy protection a step that could mean they receive little or nothing. Some people hire a debt settlement firm to represent them, but others negotiate themselves. The advantage to contracting with a debt settler is saving time and avoiding the hassle of negotiating yourself.

Advantages to settling a debt:
• Pay a fraction of what you owe to become debt free.
• Mitigate the long-term credit damage of bankruptcy to your ability to borrow money.
• Negotiate with creditors and avoid the time and expense involved in bankruptcy.
Disadvantages to debt settlement:
• Creditors might not want to negotiate with you.
• When the creditors learn you can’t pay, they might file legal actions aimed at garnishing your wages.
• Stopping payments to convince creditors that you are serious about not paying could result in your accounts going into collection, further damaging you credit as your debt increases.
• If you settle a debt, state and federal tax collection will treat the forgiven amount as income and require you pay taxes on it.

Advantages and Disadvantages of Bankruptcy

Bankruptcy chapters 7 and 13 are the two avenues individuals have to clear their debts through the courts. Chapter 7 eliminates your debts, but in some states might require you to liquidate all you own, including your car and house, to help compensate your creditors.

Chapter 13 protects your home from foreclosure but requires that you partially repay creditors over a three to five year period. Because it requires repayment, it is often called “wage earners bankruptcy.” Both chapters will cause long-lasting damage to your credit report. In addition, student loan debt, income taxes and child support payments can’t be discharged in bankruptcy, so you will still be obligated to repay them.
Advantages to Chapter 7 bankruptcy:
• Clears most debts and offers a financial fresh start.
• Doesn’t require the filer to pay taxes on unpaid debts.
• Prevents creditors from pursuing collections.
Disadvantages to Chapter 7 bankruptcy:
• Damages credit report for 10 years.
• Some states allow seizure and sale of you home and other properties. You should review what is exempt in your state.
• Requires that you wait eight years before filing again under Chapter 7.

Advantages to Chapter 13 bankruptcy

• Protects your property, including your house and car, from foreclosure and repossession to cover debts.
• After you complete required payments, you receive a discharge of debt.
• You aren’t required to pay taxes on forgiven debt.
• Waiting period before you can file again is two years – six years less than under Chapter 7
Disadvantages to Chapter 13 bankruptcy:
• Requires that you follow a court-ordered payment plan that lasts three to five years.
• Reduces your credit score for years, making it difficult to borrow money or obtain credit.

Where Bankruptcy Doesn’t Help

Bankruptcy does not necessarily erase all financial responsibilities. It does not discharge the following types of debts and obligations:
• Federal student loans
• Alimony and child support
• Debts that arise after bankruptcy is filed
• Some debts incurred in the six months prior to filing bankruptcy
• Taxes
• Loans obtained fraudulently
• Debts from personal injury while driving intoxicated
It also does not protect those who co-signed your debts. Your co-signer agreed to pay your loan if you didn’t or couldn’t pay. When you declare bankruptcy, your co-signer still may be legally obligated to pay all or part of your loan. Most people consider bankruptcy only after they pursue debt consolidation or debt settlement. These options can help you get your finances back on track and won’t negatively impact your credit as much as a bankruptcy. Debt consolidation combines all your loans to help you make regular and timely payments on your debts. Debt settlement is a means of negotiating with your creditors to lower your balance. If successful, it directly reduces your debts.

Bankruptcy Lawyer Free Consultation

If you have a bankruptcy question, or need to file a bankruptcy case, call Ascent Law now at (801) 676-5506. We want to help you. Come in or call in for your free initial consultation.